On brink of U.S. crisis, a warning brushed aside at Fed

NEW YORK

The U.S. Federal Reserve Building is pictured in Washington, March 18, 2008.

Reuters/Jason Reed/Files

NEW YORK (Reuters) - As the United States teetered on the edge of financial crisis in 2007, one prescient voice within the Federal Reserve was all but silenced when he warned that problems at Wall Street bank Bear Stearns were not contained and posed "enormous risk."

It was at the U.S. central bank's policy meeting in June 2007, where policymakers discussed Bear Stearns' recent bailout of two of its hedge funds hit by losses on subprime mortgages.

Though the Wall Street bank would later prove among the first dominoes to drop in a brutal crisis and global recession, then-New York Fed President Timothy Geithner and others largely agreed that the situation was contained. It was far different, they said, than that of Long-Term Capital Management, the hedge fund that collapsed in 1998 and nearly caused a global crisis.

But Richard Fisher, the former hedge fund manager and then president of the Federal Reserve Bank of Dallas, challenged his colleagues around the table. He argued there were indeed worrying similarities between Bear Stearns and LTCM, including an over-reliance on computer-based stress tests and uncertainty around the true value of underlying securities.

"I would argue - having been in the business, although the business wasn't as sophisticated when I used to be in it - that this has broader dimensions than those we had before," Fisher said, according to a meeting transcript released on Friday.

"If you look at the growth rate of these instruments - again, without any underlying sense of what you ultimately can cash in if you're pressed - it has been a straight upcurve.

"The numbers are quite huge," Fisher added. "I don't think the issue is contained. I do think there is enormous risk."

Fisher, who remains the outspoken head of the Fed's Dallas branch, then asked that all policymakers be briefed on the Bear Stearns situation so that they are on the same page if asked publicly for their take on it. "That's just a request," he said.

That's when Geithner, currently U.S. Treasury Secretary who at the time was vice chair of the Fed meeting, said: "I don't think, Richard, you need to be in a position to offer an opinion on what happened in Bear Stearns in particular.

"I don't think you need to or want to be in the business of doing that in that particular case." (Reporting by Jonathan Spicer; Editing by James Dalgleish)

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